The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Wednesday, November 16, 2011

According to an article in Accounting Today, financial disclosure complexity overwhelms investors. Behind this conclusion is the handy work of Wall Street's Opacity Protection Team.

To see how OPT works, let's look at the article.

Investors and financial executives are increasingly feeling overloaded by the volume and complexity of financial disclosure information in annual reports and other financial filings, according to a new study.

The research report, by KPMG LLP and the Financial Executives Research Foundation, a nonprofit affiliate of Financial Executives International, found that the volume of disclosure information has increased 16 percent during the past six years, while the volume of footnotes has gone up 28 percent.

The increased volume and complexity of financial disclosure information is causing a dilemma, especially for small investors who are trying to absorb the greater amounts of data.

What is the dilemma for small investors?

If they cannot handle the volume and complexity of financial disclosure information themselves, they can hire an expert that can.

For example, individuals have long hired professional money managers at companies like BlackRock, Fidelity and PIMCO. One reason for hiring these professional money managers is the managers have the expertise and resources to handle the volume and complexity of financial disclosure.

The research was based on a survey sent to 6,500 financial executives, reviews of relevant academic literature and analysis of annual reports filed by 25 Fortune 100 companies across a range of industries.

In true Wall Street Opacity Protection mode, the authors of the report didn't even bother to survey small investors to see if more disclosure was a problem.

Rather, they surveyed the firms required to make the disclosures and concluded from their responses that small investors could not handle the disclosure. Do these survey respondents have any bias --- like not wanting to make any disclosures?

I wonder what the relevant academic literature is that shows that small investors don't know how to hire experts who can analyze the disclosures.

“The sheer quantity of financial disclosure has become so excessive that it has diminished the overall value of these disclosures,” said KPMG audit partner Terry Iannaconi, the main author of the report.

Does this mean that Warren Buffett is no longer capable of finding his way through the financial statements and accompanying footnotes?

If these disclosure are valuable for Mr. Buffett, they are valuable for the small investor who can invest in his company's stock.

One of the primary contributors to disclosure overload is the increased complexity of transactions, investments, financial instruments and relationships. The report found that annual reports have especially expanded in years in which a company was involved in an acquisition, restructuring, spinoff or similar event.

“Financial statement preparers have struggled to comply with the ever-increasing disclosure requirements, especially for footnote disclosures, and welcome these recommendations for reducing disclosure overload and complexity,” said FEI president and CEO Marie N. Hollein in a statement....

This statement needs to be re-read. Apparently, one of the reports authors, KPMG, had an incentive relate to the findings of the report. Specifically, if they could argue that investors were confused by disclosure, they could argue for doing away with disclosure.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.